The Case for Halting the Auditors' Revolving Door

Mar 4th 2002

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Law-makers and businesses are taking steps to halt the "revolving door" between auditors and their clients. Adding fuel to a legislative proposal introduced last week, Business Week released the results of its survey of chief financial officers ("The CFOs Weigh in on Reform," March 11, 2002). A majority, 58%, favor imposing a two- to five-year waiting period during which auditors may not accept senior positions with audit clients.

To understand the case for halting the revolving door, the Washington Post did some research and found that several perceived audit failures have involved financial executives recruited from the company's audit firm. Examples include Waste Management, Global Crossing, MicroStrategy and Enron.

The Post attributes the revolving door to the early retirement policies of the Big Five, who typically encourage partners to leave before they reach their mid-fifties. Other observers cite the differences in pay between public accounting and private industry.

Charles Peck, who tracks executive compensation for the Conference Board, a New York-based business research group, told the Post that chief financial officers at medium-size manufacturing firms earned an average of about $1.5 million in the year 2000 -- consisting of about $700,000 in salary plus $800,000 in additional compensation. In contrast, says the Post, partners at Big Five firms, typically earn about $500,000 a year, though lead or practice partners make about $750,000 and some can earn $1 million or more annually.

Perception or Reality?

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Often, the problem is one of perception that is difficult to dispel, as described in a 1998 article on the subject. It said, "The former auditor's knowledge of the audit firm's testing techniques may allow the client to manipulate the financial statements in ways that are least likely to be detected… Also, continuing auditors may have difficulty maintaining proper professional skepticism when questioning their friend and former colleague. Staff and senior auditors may place undue reliance on the representations of their former superior."

Trade organizations and Big Five firms defend the practice. One former Big Five partner defends his firm's system of career progression and mandatory retirement, saying, "You need to get the A players into the system" and some workers are "kind of spent" by the time they reach their late forties. But others, including some state boards, have seen the revolving door pathway to clients as dangerous. This pathway and excessively close ties between Lincoln Savings and Loan and its auditor were cited by the California Board of Accountancy as a factor in the savings and loan scandal of the late 1980s.